Down to $61.1/b with EM and metals. Time to buy

Over the past week Brent crude has sold down 3% along with EM equities (-3.5%), Industrial metals (-2.8%) plus some headwind from a 0.5% stronger USD. While not bullish to the $80/b in terms of the 2018 horizon, the OPEC+ decision last week is still supportive. Further inventory draw down will lead to a steeper Brent backwardation spot price premium to forward contracts while further US crude oil production growth is likely to lead to a yet wider Brent to WTI crude price spread. As such a Brent crude spot price delivery in the range of $60-65/b seems reasonable for 2018. Brent crude year 2018 is currently trading at $60.6/b and 2019 at $58.5/b. We expect the Brent crude front month to head towards $65-67/b in not too long.

There never was much of a bull rally following OPEC+’ firm and credible announcement last Thursday for maintaining production cuts to the end of 2018. Brent crude has instead sold off 3% w/w since last Wednesday, the day before the OPEC meeting. The sell-off has in our view little to do with oil specifics and much more to do with broad based drivers. In perspective EM equities have sold off 3.5% while the USD index has increased 0.5% with all commodity sub-indices down between 1.3% and 2.8%. All the major industrial metals were down with copper loosing 3.1% and nickel loosing 6.2%. So Brent crude loosing 3% with this kind of backdrop has little to do with oil specifics.

We still perceive OPEC+’ announcement last Thursday as an overall very strong and credible message of lasting market management. “We will not allow the inventories to rise back up”; “Production cuts will be reversed gradually” and “We’ll drive inventories down another 150 mb (vs Sep OECD level)”.

The message was however not a message of “We’ll cut so much that we’ll drive the market back to $80/b”. The market may very well drive back up to $80/b eventually, but not because OPEC+ places it there deliberately. The lack of this kind of message was maybe why the Brent crude oil price did not roll on higher after OPEC+ message but rather followed general market trends (EM and metals) lower.

In terms of hopes for a further strong bullish drive from OPEC+ the only weakness in the announcement last week was the goal of another 150 mb lower. The reason for this is that the reference point is OECD inventories from September 2017. Since then we have seen weekly data decline by close to 70 mb with probably another 20 mb lower before the end of year. In addition it will only drive OECD inventories down to the ‘2013-2017 five year average’ rather than the normal conditions of ‘2010-2014’ from before inventories started to rise.

We’ll thus be pretty close to the inventory goal already at the end of 2017 and for sure by mid-2018. And 1Q18 will not be like 1Q17 when OECD inventories jumped 82 mb from Dec-16 to Jan-17 due to elevated OPEC production in 4Q16. This time we have disciplined production by OPEC+ in 4Q17 with little reason to expect an unusual large jump in OECD inventories into January.

OPEC+’ message last week was measured and not a message of aiming for the sky in terms of prices. As inventory targets are reached they will gradually wind down cuts. Thus even if they promised to keep cuts to end of 2018 they are unlikely to over-deliver in terms of inventory target. As this target is likely to be firmly in their hands by mid-2018 we expect OPEC+ wind down production cuts in 2H18.

2018 is not going to be a year where Libya and Nigeria are going to increase production and thus counter production cuts from the rest of the OPEC+ group as was the case in 2017. Not because they have accepted a cap under the new agreement, but because they have taken out the upside production capacity in the short term. Venezuela on the other hand is likely to decline further with an extension of its current 3m y/y decline rate of -257 kb/d. Iran is likely to move sideways.

The main downside price concern for the oil market in 2018 is primarily connected to the coming tapering in bond purchases by Central Banks as well as the unavoidable debt-deleveraging in China.